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23–182 PDF 2005

PROPOSED LEGISLATIVE REMEDY FOR THE

PARTICIPATING SECURITIES PROGRAM

HEARING

BEFORE THE

COMMITTEE ON SMALL BUSINESS 

HOUSE OF REPRESENTATIVES

ONE HUNDRED NINTH CONGRESS

FIRST SESSION

WASHINGTON, DC, JULY 27, 2005

Serial No. 109–27

Printed for the use of the Committee on Small Business

(

Available via the World Wide Web: http://www.access.gpo.gov/congress/house

COMMITTEE ON SMALL BUSINESS 

DONALD A. MANZULLO, Illinois, Chairman 

ROSCOE BARTLETT, Maryland, Vice 

Chairman 

SUE KELLY, New York 

STEVE CHABOT, Ohio 

SAM GRAVES, Missouri 

TODD AKIN, Missouri 

BILL SHUSTER, Pennsylvania 

MARILYN MUSGRAVE, Colorado 

JEB BRADLEY, New Hampshire 

STEVE KING, Iowa 

THADDEUS MCCOTTER, Michigan 

RIC KELLER, Florida 

TED POE, Texas 

MICHAEL SODREL, Indiana 

JEFF FORTENBERRY, Nebraska 

MICHAEL FITZPATRICK, Pennsylvania 

LYNN WESTMORELAND, Georgia 

LOUIE GOHMERT, Texas 

NYDIA VELA ́ ZQUEZ, New York 

JUANITA MILLENDER-MCDONALD, 

California 

TOM UDALL, New Mexico 

DANIEL LIPINSKI, Illinois 

ENI FALEOMAVAEGA, American Samoa 

DONNA CHRISTENSEN, Virgin Islands 

DANNY DAVIS, Illinois 

ED CASE, Hawaii 

MADELEINE BORDALLO, Guam 

RAU ́ L GRIJALVA, Arizona 

MICHAEL MICHAUD, Maine 

LINDA SA ́ NCHEZ, California 

JOHN BARROW, Georgia 

MELISSA BEAN, Illinois 

GWEN MOORE, Wisconsin 

J. MATTHEW SZYMANSKI, Chief of Staff 

PHIL ESKELAND, Deputy Chief of Staff/Policy Director 

MICHAEL DAY, Minority Staff Director

(II) 

C O N T E N T S 

WITNESSES

Page 

Guzman-Fournier, Mr. Jaime A., Associate Administrator for Investment, 

US Small Business Administration .................................................................... 3

Lerner, Mr. Josh, Jacob H. Schiff Professor of Investment Banking, Harvard 

Business School .................................................................................................... 5

Mercer, Mr. Lee, President, National Association of Small Business Investment Companies ................................................................................................... 8

APPENDIX

Opening statements: 

Manzullo, Hon. Donald A. ................................................................................ 26

Velazquez, Hon. Nydia ..................................................................................... 28

Prepared statements: 

Guzman-Fournier, Mr. Jaime A., Associate Administrator for Investment, 

US Small Business Administration ............................................................. 30

Lerner, Mr. Josh, Jacob H. Schiff Professor of Investment Banking, Harvard Business School .................................................................................... 34

Mercer, Mr. Lee, President, National Association of Small Business Investment Companies ..................................................................................... 41

Additional material: 

Letter to US Small Business Administration Administrator Hector 

Barreto from Chairman Donald Manzullo and Ranking Member Nydia 

Velazquez ....................................................................................................... 64

(III) 

(1)

PROPOSED LEGISLATIVE REMEDY FOR THE 

PARTICIPATING SECURITIES PROGRAM 

WEDNESDAY, JULY 27, 2005

HOUSE OF REPRESENTATIVES

COMMITTEE ON SMALL BUSINESS

Washington, DC 

The Committee met, pursuant to call, at 10:12 a.m. in Room 

2360, Rayburn House Office Building, Hon. Donald Manzullo 

[Chairman of the Committee] presiding. 

Present: Representatives Manzullo and Velazquez

Chairman MANZULLO. Good morning, and welcome to this hearing on a very important topic for small businesses around the country: access to capital. 

I am sorry I was late, but it is impolite to walk out when the 

President is speaking. And so I followed the protocol and waited 

until an opportunity arose for me to leave there and come here. 

In April of this year, this Committee held a hearing on the importance of the participating securities program with small businesses needing equity investment. We also learned about the equity gap that exists between angel investors and venture capitalists. 

The Administrator, on more than one occasion, has given his 

word to help us work toward a solution. Yesterday, I, along with 

Mr. Ramstad of Minnesota, introduced legislation HR 3429 that 

would fix the problems caused by the participating securities program. 

Both the SBA and industry have had ample time to consider the 

merits of the draft bill. 

I look forward to the testimony of both witnesses regarding key 

aspects of the bill, such as conformity with the Credit Reform Act, 

and repayment of principle and interest back to the government. 

I now turn to the Ranking Member for her comments. Mrs. 

Velazquez? 

Ms. VELAZQUEZ. Thank you, Mr. Chairman. 

In today’s economy, access to capital is clearly the key to a successful small business. In particular, venture capital has become 

the lifeblood for entrepreneurs. 

If you look back through our nation’s history, when venture capital is available to small business owners, the effects are amazing. 

One of the main contributing factors to the economic boom of the 

1990s was increased flow of venture capital. 

Unfortunately, venture capital is simply not accessible to many 

entrepreneurs just starting out today, particularly minority business owners. That is why programs, such as the Small Business InVerDate 0ct 09 2002 12:53 Dec 01, 2005 Jkt 000000 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 G:\HEARINGS\23182.TXT MIKE
2

vestment Company, are so important. This program has been internationally recognized, and has a proven record. Since 1994, it has made $8.5 billion in participating securities investment, which led to the creation of over 228,000 new jobs and 

$39 billion in revenue. 

As this Committee is well aware, the SBIC program has now 

been shut down for nearly nine months. Since that time, the Bush 

Administration has failed to provide any solution to ensure venture 

capital is going to small businesses. And as a result, they have 

been getting less and less. 

Today’s hearing will begin to look for a solution, with a review 

of a proposal that I am sure is just one of many to come. It is my 

hope that this hearing will steer the Administration forward into 

finally taking some action. 

It is important today, as we look into reopening the program, we 

address some of the longstanding issues that have plagued the 

SBIC program in the past. This program has proven its effectiveness, but it has the potential to provide even more venture capital 

to those who need it most. 

Clearly, early-stage companies and minority-owned companies 

who rely heavily on this program as a source of seed capital need 

it the most. 

In the 1990s, SBIC made nearly 50 percent of their investments 

in start-ups. However, this dropped to 30 percent over the past two 

years. We must ensure there is no further decline, and that the 

SBICs are not limited by any burdensome barriers, so they can 

continue to make these investments. 

Minority-owned businesses need this investment, as well. Right 

now they receive only 2 percent of all venture capital investment. 

And in 2004, only 11 percent of the total SBIC Program financing 

went to minority-owned firms. 

For a program that was supposed to help close this gap, this is 

unacceptable, and something needs to change. In addition, it is important for Congress to recognize that the SBIC Program may have 

to operate with an appropriation. 

With the volatile nature of equity capital, if we have learned anything from past failures, it is that the government cannot always 

get something for nothing. 

First and foremost, I want to make one thing clear. Operating 

the program at no cost to the government is not the priority here. 

The goal is to have an affordable equity program for small businesses. If that means having the government match lenders and 

small businesses’ commitments, then so be it. 

We should also use this opportunity to broaden the scope of the 

program and the participants it attracts. An important step in 

doing this is ensuring that the application process is easy to navigate and inviting to users. 

Historically, the licensing approval process has been a mystery 

to those who have to use it. In order to create more diversity 

among the industry and create new appeal, we must make these 

processes more transparent. This will guarantee that no applicants 

are turned away due to a difficult approval process. 

The other important component is making sure this proposal is 

attractive to the investment community. Congress can think a proVerDate 0ct 09 2002 12:53 Dec 01, 2005 Jkt 000000 PO 00000 Frm 00006 Fmt 6633 Sfmt 6633 G:\HEARINGS\23182.TXT MIKE
3

posal is wonderful, but if those that us it and invest in it do not 

think so, all of this work will amount to nothing more than wasted 

time. 

These investors are the foundation of the program, and are vital 

in ensuring capital is available to all small businesses. 

In addressing these longstanding issues as we look to reopen the 

program, we will not just have a program for the sake of the program, but we will have one that is open, accessible, affordable, and 

focuses on the sectors that need it the most: minorities and startups. 

If this country continues to rely on this nation’s entrepreneurs to 

spur economic development and create jobs, the need for venture 

capital only continues to grow. That is why the need for the SBIC 

Participating Security Program is crucial. Small businesses need a 

true equity program, and most importantly, this nation relies on 

this source of venture capital to help small firms advance our nation’s economy forward. 

And that is the end of my statement, Mr. Chairman. Thank you. 

Chairman MANZULLO. Thank you very much for that very thorough statement and insight into the program we all share, and 

that is lack of capital. 

We only have one panel and three witnesses. I want to set a 10-

minute clock, and not really worry about that. 

Our first witness from the Administration is a statement that I 

know will run more than that. 

[Laughter.] 

Chairman MANZULLO. Well, if not— 

Mr. GUZMAN-FOURNIER. Probably five minutes. 

Chairman MANZULLO. Well, whatever you like. You do not have 

to go 10 minutes. So we look forward to the testimony of Jaime 

Guzman-Fournier, Associate Administrator for Investment, US 

Small Business Administration. I just did not want to cut you off 

on time. 

Mr. GUZMAN-FOURNIER. All right. 

Chairman MANZULLO. We look forward to testimony, and the 

complete statement of the witnesses and all the Members will be 

made part of the record. 

Thank you. 

STATEMENT OF MR. JAIME A. GUZMAN-FOURNIER, US SMALL 

BUSINESS ADMINISTRATION

Mr. GUZMAN-FOURNIER. Mr. Chairman, Ranking Member Velazquez, Members of the Committee, I appreciate the opportunity to 

offer testimony on the Small Business Investment Company program, and the legislative proposal that attempts to correct the serious flaws in the Participating Securities program. 

In considering this proposal, we need to ensure that the failures 

and losses of the Participating Security program are not repeated. 

We are all familiar with the current estimates that project losses 

of over $2.7 billion on the more than $6 billion of participating securities disbursed through Fiscal Year 2004. In reviewing the ParVerDate 0ct 09 2002 12:53 Dec 01, 2005 Jkt 000000 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 G:\HEARINGS\23182.TXT MIKE
4

ticipating Debentures proposal, the Administration needs to ensure 

that these losses would not occur again. 

The Administration has studied the draft proposal to create a 

new form of SBIC security, called Participating Debenture. As we 

understand this proposal, the most basic features of this debenture 

are: a deferred-interest debenture with accrued interest unconditionally payable by the SBIC five years after issuance, and semiannually thereafter. Additional payments are required if the SBIC 

has gross receipts, as defined by statute. 

The participating debenture principal would be due and payable 

at the end of year 10, although it could be paid earlier. 

However, the proposed legislation is unclear as to whether the 

trust certificate holders are entitled to regularly-scheduled interest 

payments during the first five-year deferral period, or whether interest on the trust certificate is also deferred. 

SBA is further concerned that, although the SBICs are liable for 

interest payments, that their ability to make these payments is 

still largely dependent on the success of the fund. Five years of deferred interest on millions of dollars is a large sum of money. If 

SBICs are unable to make their significant interest payments at 

year five, the SBA will be required to make the payments on their 

behalf, as well as liquidation procedures to purchase the trust certificate. Unfortunately, SBA may ultimately be the party making 

the interest payments for the first five years. 

While this proposal appears to address some of the significant 

issues identified in our written testimony, such as ensuring that interest is unconditionally owed by the SBICs, many other important 

issues are still unclear. 

Last week, SBA provided the Committee with a number of questions regarding the structure, funding mechanism, distribution 

framework, and other features of the proposed participating debentures. We also requested information explaining the priority, 

amount, and timing of all of the payments associated with the participating debentures, which will help us in evaluating whether it 

is a debt or equity security, and its potential budgetary cost. 

Some examples of questions submitted include: 

Requesting a comparison of Participating Securities program 

cash flows to the Participating Debentures program. 

Requesting information as to who would issue the trust certificates—the SBA, the SBICs, or another entity—and whether SBA 

would advance interest payments to the trust certificate holders on 

behalf of the SBICs. 

Clarification, by way of specific examples, on how the distribution formula would work, identifying what payments the various 

parties would receive from the SBICs. 

Clarification as to whether SBA leverage is fixed at two tiers lifetime, or is refinanceable. 

These are a few examples of some of the critical questions raised 

during our initial review of the draft Participating Debenture proposal. We have received a preliminary response on some of these 

issues from the National Association of Small Business Investment 

Companies, to which the Committee had forwarded our questions 

and we look forward to receiving a complete response, and discussing these issues with you and your staff. 

5

As we have suggested above, experience with the Participating 

Securities program can provide valuable insight into the present 

proposal. A thorough examination of all potential effects of the proposed Participating Debentures program is warranted, so that all 

costs can be properly identified and assessed. 

Understanding the structure of the financial terms is important 

to ensure that the benefits to investors and small businesses are 

weighted against the cost to taxpayers. 

I applaud the Committee for taking the time to address this complex proposal. I and my staff at SBA look forward to working with 

the Committee to consider all aspects of this legislation. Such work 

is necessary to ensure a full examination of the feasibility of the 

Participating Debentures proposal. 

Thank you again for the opportunity to testify, and I look forward to your questions. 

[Mr. Guzman-Fournier’s statement may be found in the appendix.] 

Chairman MANZULLO. Thank you so much. Our next witness has 

just been elevated to the faculty of Harvard Business School. Josh 

Lerner is a Professor of Investment Banking at Harvard Business 

School, Director of the Entrepreneurship Working Group, and 

comes with a very distinguished background. He has written several books on venture capital. 

Unfortunately, he could not make it, so Mike Arlinsky, Chief 

Clerk of the Committee, will be reading the testimony of Professor 

Lerner. And Mike, that is probably about the easiest degree you 

picked up. Is that correct? We look forward to your testimony. 

STATEMENT OF MR. JOSH LERNER, HARVARD UNIVERSITY

Mr. ARLINSKY. The statement of Josh Lerner, read into the 

Record. 

My name is Josh Lerner. I am the Jacob H. Schiff Professor of 

Investment Banking at Harvard Business School, and the director 

of the Entrepreneurship Working Group and the Innovation Policy 

and the Economy Group at the National Bureau of Economic Research. I appreciate the opportunity to submit this statement to the 

Committee. 

The Committee is to be commended for taking a careful look at 

the Small Business Investment Company program. The program 

has a storied history, and played an important role in jump-starting the venture capital industry. 

At the same time, given the tremendous growth in private sector 

venture capital activity, it is natural to A, if the program is still 

needed, and B, if the reforms proposed in the proposed legislation 

help the program better address these challenges. 

In this testimony I outline my concerns with two aspects of the 

proposed legislation. 

First, it is important to note that the SBIC program’s history 

provides a great example of how public venture programs can help 

a nation build venture-investing infrastructure for the first time. 

To be sure, after the launch of the program in 1958, SBICs drew 

criticism for the low financial returns generated, and the fraud and 

6

waste associated with some funds. Viewed with hindsight, however, 

the program takes on a different appearance. 

Though few of today’s significant funds began as a part of the 

SBIC program, the program did stipulate the proliferation of may 

venture-minded institutions in Silicon Valley and Massachusetts’ 

Route 128, the nation’s two major hotbeds of venture capital. These 

institutions included law firms and accounting groups geared specifically to the needs of entrepreneurial firms. 

For example, venture economics, which originated as the SBIC 

Reporting Service in 1961, gradually expanded its scope to become 

the major source of returns data on the entire venture industry. 

Moreover, some of the United States’ most dynamic technology 

companies received support from the SBIC programs in the 1960s, 

1970s, and 1980s, before they went public. 

But it is also important to note that the venture capital market 

has changed dramatically since the establishment of the SBIC program in 1958. The pool of venture capital under management today 

is, in inflation-adjusted terms, more than eight times the size of 

that of a decade ago, and many hundred times of that three decades ago. 

The pace of venture capital investment, while down from the 

overwrought levels of the bubble years, is still 10 times greater in 

real terms than the rate even a dozen years ago. In the eyes of 

many observers, as a review of recent issues of publications from 

Business Week to The Private Equity Analyst will reveal, we today 

have too many venture funds with too much capital chasing a limited number of attractive investments. 

These general observations about the market are underscored by 

my experience with the SBIC program participants. To be sure, 

many SBIC-backed funds are run by great individuals who are targeting underserved markets. 

But far too many of the SBIC participants in recent years have 

been marginal venture funds whose investments and approaches 

are not really different from their peers, with one important difference: the experience of the teams and investment theses of the 

funds are sufficiently tenuous that they cannot raise funds from 

the traditional pension funds, endowments, and other limited partners, without the program’s assistance. It is very hard to see how 

many of these groups have addressed a market failure of any type. 

The emergence of a successful private venture capital industry is, 

thus, in many senses a tribute to the SBIC program. But at the 

same time, this growth raises important questions about the program. Is the SBIC program still needed today? If so, how should 

it be structured? 

Turning now to the specifics of the legislation, I have two major 

concerns. The first relates to its reliance on debt instruments; the 

second is the lack of any mandated assessments of the program’s 

contribution. 

First, this legislation calls for the government contribution to 

SBICs to be in the form of debt securities. In my eyes, this seems 

troublesome, since it introduces inappropriate incentives and ignores global best practice. 

The problem with financing venture funds with debt is that organizations that have to make debt repayments will tend to make 

7

low-risk investments in relatively mature firms, in order to ensure 

that they are able to repay their obligations. 

Moreover, the ownership claims issued by the government are 

quite different from those provided to private investors, introducing 

additional potential conflicts. 

These incentive problems are particularly worrisome since they 

will push SBICs to make investments where they do not appear to 

be most needed. An extensive literature on capital constraints and 

entrepreneurship suggests that if there is a market failure in the 

US for funding growth companies, it is among the very small, highrisk firms. 

Firms with a real business plan and revenues today are likely to 

be able to attract plenty of equity or debt investors. Yet the proposed design of the SBIC program is pushing funds to make investments in precisely these lower-risk categories. 

The Committee should thus consider alternative program designs 

that address these incentive problems. One model that is being 

emulated around the globe today is the Israeli Yozma program. 

In June, 1992, the government established Yozma Venture Cap- ital, Ltd.—Yozma means initiative in Hebrew—a $100 million fund 

wholly owned by the Israeli government. 

Yozma had three goals. To promote the growth of promising 

high-tech firms in Israel; to encourage the involvement of major 

international corporations in the Israeli technology sector; and to 

stimulate the development of a professionally-managed, privatesector venture capital industry in Israel. 

Yozma, like the SBIC program, also shared the risks associated 

with venture capital investments. Yet it did so using a structure 

that was much more similar to equity, and thus avoided many of 

the problems delineated above. 

More specifically, the legislation that created Yozma allowed the government to contribute up to $8 million to a particular venture 

capital fund. These laws also required the venture capitalist to 

match the $8 million by raising at least an equal amount of money 

from limited partners. Therefore, the limited fund size was $16 million. 

Thus, if one of these funds tripled in value over seven years, net 

of fees and incentive compensation, both the limited partners’ and 

Yozma’s investment would also triple, from $8 million to $24 million. 

The limited partners could then contribute additional funds to 

buy out Yozma’s $24 million stake for about $10 million. These 

partners would therefore collect $38 million on the fund’s $18 million overall investment, turning an annual return of 17 percent 

into one of 25 percent. 

This enhancement to returns was accomplished without exposure 

to the risks and the potential distortion of behavior that would 

have occurred if the Israeli government made loans to the venture 

fund. 

My second major concern with the legislation is a lack of a mandate to carefully evaluate how the SBIC program is working, and 

whether it is still needed. As noted above, the venture capital has 

changed dramatically in recent decades, raising questions as to the 

role that the SBIC program plays today. 

8

There is a real need to evaluate the SBIC program on a periodic 

basis. This should be a rigorous and dispassionate analysis of the 

program’s success to date. The evaluation should also consider the 

overall venture capital climate, and whether the economic rationales that originally justified the program’s creation still apply. 

It is interesting to note that in recognition of the success of the 

Yozma program, the Israeli government privatized its stake in the 

fund in 1998, declaring the goals of the program met. 

In short, the SBIC program has historically played a critical role 

in encouraging the development of the American venture capital industry. Given the changes in the private venture capital industry, 

it is reasonable to ask whether the program is still needed; and if 

so, what structure would be optimal. 

I believe that the reliance on debt securities and the lack of a 

mandate for formal evaluations of the program in the proposed legislation both raise serious issues. 

[Mr. Lerner’s testimony may be found in the appendix.] 

Chairman MANZULLO. Thank you, Professor. We look forward to 

grilling you with very difficult questions. 

I was just kidding, Mike. The next witness is Lee W. Mercer, 

who is with the National Association of Small Business Investment 

Companies. 

Mr. Mercer, we look forward to your testimony. You can take the 

liberty, if you want, to incorporate your testimony into the two 

questions or two concerns that were raised in the written statement of Mr. Lerner. 

We look forward to your testimony. 

STATEMENT OF MR. LEE W. MERCER, NATIONAL ASSOCIATION 

OF SMALL BUSINESS INVESTMENT COMPANIES

Mr. MERCER. Thank you, Mr. Chairman, Ms. Velazquez, and 

Members of the Committee. And I will probably address some of 

Professor Lerner’s statements later on. I will go through a little bit 

of my testimony first. 

And I will start by saying that in April, expert witnesses, perhaps not Professor Lerner, but other expert witnesses, and company CEOs confirmed the failure to agree on a new structure to replace the Participating Security program will have a significant 

negative impact on equity capital available to US small businesses. 

They confirmed the gap that is filled by the program. 

It will continue the break in the pipeline of new funds that we 

are experiencing this year. If new funds are not being formed every 

year, the capital available to small businesses will dry up quickly. 

H.R. 3429 provides a structure that can solve at least a large 

part of the problem. Perhaps, as Professor Lerner has said, not all 

of the problem, but a large part of the problem. And we urge the 

Committee to work for its enactment in a final form later this year. 

H.R. 3429 meets the qualification requirements of the Credit Reform Act. We are here because the Credit Reform Act does not 

allow for an equity security, as Professor Lerner suggests. 

9

It would substantially accelerate and increase the percent of returns to SBA in all funds, and make interest and principle chargeable against private capital, whether or not a fund is profitable. 

In addition, SBA’s share of the profits and funds that produce 

greater returns would be approximately 260 percent greater than 

SBA’s share of profits in participating security funds drawing leverage at current interest rates. This would assure that SBA would 

enjoy substantially larger returns in those funds that can most afford to pay it. 

We are confident that the proposed legislation would carry a zero 

subsidy rate for appropriations purposes if scored reasonably. 

Now let me address some of the specifics of the legislation. As 

far as Federal Credit Reform Act qualification is concerned, I believe that there can be no doubt that the security created by the 

proposed legislation is a debt security, for the purposes of the Act. 

Attached to my testimony is an opinion of counsel from the law 

firm of Kirkland and Ellis to that effect. We believe that that issue 

is behind us, one that has kept us essentially from the negotiating 

table, we believe, with the Administration for about a year now. 

H.R. 3429 has a dramatically improved financial structure. It 

will dramatically improve SBA’s financial position in Participating 

Debenture SBICs, compared to SBA’s position in Participating Security SBICs. It will do that in the following ways. 

First, interest on participating debentures would be payable, irrespective of the SBIC’s profitability, and would be chargeable 

against the SBIC’s private capital. That is not true in the Participating Security program, in which interest is called ‘‘prioritized 

payment,’’ and is payable only to the extent of a Participating Security SBIC’s earnings. It is not chargeable in any degree against the 

private capital of a Participating Security SBIC. 

And while interest would be deferable under certain circumstances during the first five years, SBA would not have to advance that interest to the holders of securities used to finance leverage. Again, that is substantially different from the current program. And the proposed legislation makes that clear in paragraph 

K2B, concerning the timing of payments. 

Second, in HR 3429, distribution of any gross receipts, as defined 

in the legislation, would be mandatory, whether or not there were 

realized earnings for accounting or tax purposes. This is not true 

in the Participating Security program, where distributions are 

made only from realized earnings available for distribution. 

The change would result in substantially earlier distributions to 

SBA that would pay down interest and leverage faster than is the 

case in the Participating Security program. That alone is a substantial reduction in risk for the government. 

Third, HR 3429 provides that accrued interest would be paid first 

from any distribution, as is the case in the Participating Security 

program. However, after payment of interest, remaining amounts 

to be distributed would be distributed pro rata to SBA or to the, 

actually to the pools issuing the leverage, and private investors, according to their interests in the SBIC, until all outstanding SBA 

guaranteed leverage is paid in full. 

That is not true in the Participating Security program, in which 

SBA’s share of such distributions over and above interest payments 

10

is only about 7-1/2 percent in funds for which SBA has provided 

up to 50 percent of the capital. 

In HR 3429, SBA’s share would be 50 percent in that example, 

an approximately 565-percent increase in the acceleration of funds 

flowing to pay back leverage. At a maximum permissible leverage 

ration of two thirds of the fund’s capital, HR 3429 would provide 

that SBA’s share is increased by 33-1/3 percent. 

Fourth, HR 3429 provides that all sums distributed to SBA over 

and above that required to repay accrued interest would be used 

to repay leverage, until leverage is paid in full. That is not the case 

in the Participating Security program, in which SBA books profits 

before reducing leverage. 

The result of this anomaly is that the Participating Security program, in that program SBA has been called upon to honor its guarantee of some leveraged principle and related interest payments in 

funds where there were early gains, but later losses, unnecessarily 

increasing interest expense, and potential loss for the government. 

Finally, SBA’s share of the profits in the Participating Debenture 

SBICs would be greatly increased compared to SBA’s share in typical Participating Security SBICs. This would be accomplished by 

a two-tier profit-sharing program. 

After all interest in SBA-guaranteed leverage has been repaid, 

SBA would receive a base profit share of approximately 10 percent 

in a participating debenture fund leveraged at a two-to-one ratio. 

And that would continue until a fund’s private investors received 

distributions equal to their original investment. That is about a 

median performance in the venture capital industry. 

Thereafter, SBA would receive about 27 percent of all remaining 

funds of the applicable distribution. 

In marked contrast, at the current 10-year Treasury Bill rate, 

SBA’s share of all profits in a participating security fund is only 

about 7-1/2 percent, not the 27 percent. 

The result of this increase in SBA’s share would be approximately 260 percent. Maximizing SBA returns from the most profitable funds will greatly reduce risk of loss to the government. 

Finally, I am heartened by the Administration’s testimony, in 

that, as Mr. Guzman has suggested, it is an offer to sit down together with the Committee’s staff to probe the intricate particulars 

of the structure in HR 3429. We welcome that dialogue, and look 

forward to moving forward to what we hope will be a successful 

passage of legislation this year. 

As far as Professor Lerner is concerned, part of his testimony 

should be more applied to the April hearing about the need for the 

program. And he raises some questions about whether there is a 

need for the program. 

His position does not necessarily say no. There were experts at 

the April hearing who took the opposing view, among them the 

Tuck School at Dartmouth College, in a very detailed report that 

the Committee has received. So I guess we are at the point where 

we know that experts can differ. 

As to his suggestion that using debt securities to fund an equity 

program causes some difficulties, there is no question but that he 

is correct. However, the government is constrained by the Credit 

Reform Act if it wants to adopt a program that can operate as a 

11

subsidy program costing the government less than 100 cents on the 

dollar for every program dollar to be invested. 

So I think he raises questions that need to be addressed. Some 

of them I think have been addressed in the April hearing; others 

are more properly a consideration of the role of the Credit Reform 

Act. 

Thank you very much, Mr. Chairman, Ms. Velazquez, for your 

attention. 

[Mr. Mercer’s testimony may be found in the appendix.] 

Chairman MANZULLO. I think I just have a couple of questions. 

Mr. Guzman, would you agree that the proposed bill conforms 

with the Credit Reform Act? 

Mr. GUZMAN-FOURNIER. Mr. Chairman, we are still reviewing the 

proposal, and have not yet made a determination on that. 

Chairman MANZULLO. The questions that I was going to ask really came up in the testimony of the Professor. And I have no more 

questions. I would then defer to Mrs. Velazquez. 

Ms. VELAZQUEZ. Thank you, Mr. Chairman. I do have a lot of 

questions. And I would like to go first to Mr. Guzman. And then 

if you have any other questions—thank you. 

Mr. Guzman, looking at your testimony, you criticized the Participating Securities program for its losses. In doing so, you suggest 

that these losses justified the elimination of the government’s role 

in the sector of the capital market. 

There is a need for the program, particularly one that provides 

equity investment to start-up companies. I say we need to make a 

distinction here. Just because a program costs money does not 

mean that it should be done away with. And there are a lot of programs that have costs associated with them, that I don’t hear the 

Administration calling for their elimination. 

So setting the current Participating Securities program aside, 

given that so little venture capital is going to small businesses, 

why, then, your testimony seemed to indicate that there is no need 

for an equity program? 

Mr. GUZMAN-FOURNIER. I think more than the question of a need 

at this point, what we are talking about, what we are analyzing 

back at the SBA is the cost of the program. And making an assessment as to whether the cost of this program on balance merits having it at all. 

Ms. VELAZQUEZ. Mr. Guzman, cost aside, do we need this type 

of program? 

Mr. GUZMAN-FOURNIER. I guess that is the question that even experts right now are disagreeing. I mean, I do not— 

Ms. VELAZQUEZ. The expert is not saying that we do not need the 

program. He is talking about the start-ups and minority businesses. 

Mr. GUZMAN-FOURNIER. Right. Well, I think we do not, to be 

quite honest about it, I do not think we have enough data— 

Ms. VELAZQUEZ. I think you are not going to answer my question. 

Maybe you will answer my next question. 

What is the Administration’s position on this proposal? 

Mr. GUZMAN-FOURNIER. Right now our position is that we are reviewing it, because it is a complex proposal, as I am sure you know. 

Ms. VELAZQUEZ. Okay. So— 

12

Mr. GUZMAN-FOURNIER. And we have not made a determination, 

as I mentioned to the Chairman, about whether it meets or not 

credit reform. 

Ms. VELAZQUEZ. Okay. Can we get a commitment that you will 

provide the Administration’s position, whether or not you support 

or oppose this proposal, within the next two weeks, in writing? 

Mr. GUZMAN-FOURNIER. The first question we need to resolve 

here is, do we have a program that meets credit reform? I think 

that is critical. And that determination has not been made yet. 

But that determination will be made at some point. Once that 

determination is made, then we are offering here to continue working with the Trade Association and the Committee to see if we can 

come up with a proposal that, again, makes sense from a cost 

standpoint. 

Ms. VELAZQUEZ. Mr. Guzman— 

Mr. GUZMAN-FOURNIER. We are really focusing on the cost. I 

want to add this. Because mainly what we are seeing here, and as 

I look at what I am currently overseeing in this division, is we 

have a program that, in its cash position right now, is at negative-

$1.7 billion. 

And this program, it is supposed to mirror in a way what that 

program was intended to do. So we want to make sure that whatever we do here, we do it with caution, and with enough carefulness so that we do not run into that type of situation again. 

Ms. VELAZQUEZ. But the program has been shut down now for 

nine months. We held a hearing here, where you participated in, 

two years ago. And we had experts on the industry, and we discussed the problem of the program. And yet, the Administration 

has not come up with any solutions, either, or any proposal. 

So do we, I guess that once you decide and make an assessment, 

you will be submitting to us, or at least to me, your position, the 

Administration’s position. 

Mr. GUZMAN-FOURNIER. We can at some point, once we resolve 

the issue of the credit reform, at some point we are going to have 

to go into the details of the proposal. 

And yes, the Administration at some point is going to have to 

have the position. 

Chairman MANZULLO. Would the gentlelady yield? 

Ms. VELAZQUEZ. Yes. 

Chairman MANZULLO. You know, I am the Chairman of this 

Committee, and we are the Committee of jurisdiction. You were 

given this three weeks ago. At what point are you going to take a 

detailed look at this thing? 

Mr. GUZMAN-FOURNIER. Well, we submitted 35 questions. That is 

detailed. And it took us about two weeks to develop those 35 questions. And the National Association of Small Business Investment 

Companies has kindly responded to some of those questions. But, 

as Lee and I spoke earlier, not all of them have been answered. 

And particularly the most important one— 

Ms. VELAZQUEZ. Reclaiming my time, Mr. Chairman, well, it does 

not surprise me that it is going to take forever. We passed a 

Women Procurement program for four years now, and you are still 

studying it. 

13

Mr. GUZMAN-FOURNIER. When we have a program that is at a negative-$1.7 billion, you have— 

Ms. VELAZQUEZ. Let us go to my next question. 

Mr. GUZMAN-FOURNIER. —to take prudence here. 

Ms. VELAZQUEZ. Each year, the issue of the low level of minority 

investment in the SBIC program is brought up. And each year, 

nothing changes. 

Last year minority businesses received below 6 percent of SBIC 

financing. Clearly, you are doing nothing, or either what you are 

doing is not working. 

So what do you intend to do? What is it that the Administration, 

what is it that the Administrator intends to do to change? 

Mr. GUZMAN-FOURNIER. We have had a program for the last two 

and a half years of reaching out and trying to—the critical question 

here is, and I said it on my previous hearing here in April, is we 

need to look at who is out there targeting this segment of the population, this business segment. And there are people qualified to do 

this type of investing. 

We have had a program of reaching out and trying to find who 

they are, and inviting them to apply. They have to go through a 

rigorous process, as any other individual would go. And at the end 

of the day, our intent is to— 

Ms. VELAZQUEZ. But in the year 2000— 

Mr. GUZMAN-FOURNIER. What? 

Ms. VELAZQUEZ. In the year 2000, 11 percent of venture capital 

went to minorities. Now it is down to 6 percent. So what kind of 

outreach are you doing? 

Mr. GUZMAN-FOURNIER. Well, here is the thing. We do not invest 

in, this program does not invest directly in businesses. We do it 

through venture capitalists that we kind of, in a sense, ‘‘hire’’ to 

do it. And we need to target that area of the hiring, and who are 

we licensing here, so that we have some areas that might not be 

covered as well these days, to be— 

Ms. VELAZQUEZ. For a long time now. 

Mr. GUZMAN-FOURNIER. —covered more. 

Ms. VELAZQUEZ. The proposed legislation, while designed to comply under credit reform as a debt program, seeks to encourage 

SBICs to make equity investments. What sort of complications can 

arise when a debt structure is used to facilitate equity investment? 

Mr. GUZMAN-FOURNIER. Well, we have two main concerns here. 

The proposal creates a security that is repaid on the same basis as 

the private equity capital. In other words, the participating debenture gets repaid at the same time as the limited partner’s equity 

investments in an SBIC. 

So we are analyzing all the features to determine whether, even 

though it gets repaid on a par with the equity, the participating debenture might still be a debt security. That is an important question. 

Ms. VELAZQUEZ. And do you believe that the proposal will provide SBICs with the same incentive to invest in early-stage companies as the Participating Securities program did? 

Mr. GUZMAN-FOURNIER. That is another good question. And because of the deferral of interest that is part of this proposal, we 

also need to sit down and discuss that. Because that means that 

14

by year five, if it is a five-year deferred interest, this money is 

going to come due. And that is going to affect, in my view, the business plans of these funds. Because they are going to have some 

pressure to come up with that money at that time, and the type 

of investing that they would do would be affected, in my view. 

Ms. VELAZQUEZ. So under this structure, do you think it will increase investment for small companies, start-ups? Or it will decrease it? 

Mr. GUZMAN-FOURNIER. We are not sure about that. We are not 

sure about that. 

Ms. VELAZQUEZ. Do you believe that SBA’s proposed profit participation is structured in a manner consistent with the amount of 

SBA investment in the program? 

Mr. GUZMAN-FOURNIER. The profit participation is almost kept at 

the same levels as they were in the participating program, where 

we put two thirds of the capital on the first tier—and I think Lee 

alluded to the tiers. 

The first tier of the profit participation will be 10 percent coming 

back to the government. That is the same percent we are pretty 

much getting in the participating program. 

Then after the private limited partners get fully repaid, we 

would then get an additional second tier of capital. Which again, 

we have brought up in the questions we sent to the Committee as 

another issue we have. 

Ms. VELAZQUEZ. Okay. Do you believe that the proposed tax distribution for private investors could limit SBA return; and thus, 

make a zero-subsidy rate difficult to achieve? 

Mr. GUZMAN-FOURNIER. We think that the tax distributions 

would most likely have a negative impact on the—negative meaning not good, or a good impact, because it gets confusing when you 

talk about subsidy rates. But it is not going to have a good impact 

on the subsidy rate. 

Ms. VELAZQUEZ. So are you confident that the proposal will operate at a zero-subsidy rate over the long term? 

Mr. GUZMAN-FOURNIER. We are not. 

Ms. VELAZQUEZ. In your opinion, do you believe that an equity 

investment program designed for higher-risk start-ups require an 

appropriation to function over the long term? 

Mr. GUZMAN-FOURNIER. This is the question about whether this 

should be a grant program? Is that a better rephrasing of it? 

Ms. VELAZQUEZ. No. If there should be an appropriation, a fund, 

an allocation. 

Mr. GUZMAN-FOURNIER. It would have to be analyzed, in the 

sense that in a grant program—here we are paying— 

Ms. VELAZQUEZ. It is not a grant program. 

Mr. GUZMAN-FOURNIER. Well, I am sorry. Here the venture capitalist would receive salaries out of this money. And that is a question we have. 

I mean, managers here, with an appropriation in this type of environment, managers tend to get highly paid. And that is something we would need to look at. 

Ms. VELAZQUEZ. This is about— 

Mr. GUZMAN-FOURNIER. I do not think the government is right 

now involved in any way in this type of, at this level— 

15

Ms. VELAZQUEZ. Keeping the program and the costs of the program low for the investors and the borrowers for the start-ups, so 

that the fees are not high. 

Mr. GUZMAN-FOURNIER. Yes. 

Ms. VELAZQUEZ. And we keep the fees and the fee structure low. 

So then we will need an appropriation coming from the government. 

Mr. GUZMAN-FOURNIER. Yes. If the program does not score at 

zero subsidy, it would need, it would require an appropriation. The 

question is whether, at the end of the day, when we see the cash 

flows and the distributions, and all the things that are going to be 

coming back to repay this leverage, whether they are going to meet 

the zero- subsidy criteria. 

Ms. VELAZQUEZ. Thank you. Mr. Mercer, just yesterday an Ernst 

and Young Venture One report showed that venture capital is 

being directed to our later-stage companies, at the highest rate in 

nearly four years. This confirms what our Committee’s record 

shows; that the greatest shortage of capital is for early-stage companies. 

Do you agree with that assessment? 

Mr. MERCER. I think that is probably true, yes. 

Ms. VELAZQUEZ. The Participating Security program’s investment 

in start-ups has declined from 50 percent in the nineties to 30 percent today. How will the proposed legislation reverse this trend? 

Mr. MERCER. I cannot truthfully say that it would reverse that 

trend. I don’t know whether it would go any lower. But clearly, 

those who have said that requiring SBICs to pay interest in the 

fifth year would require that at least a large portion of their investments be in small companies that were later stage than start-ups 

is true. 

I think that there would still be room for balanced funds that 

would do some early-stage investing, along with later-stage investing, in order to— 

Ms. VELAZQUEZ. Thank you, Mr. Chairman. And I will appreciate 

this later on, I will come back. 

Chairman MANZULLO. Absolutely. I want to turn to Mrs. Moore 

from the great city of Milwaukee, where I went to Marquette Law 

School. And then when we are completed with your questions, we 

will go back to Mrs. Velazquez to finish the rest of her questions. 

Go ahead. 

Ms. MOORE. Well, thank you, Mr. Chairman. And indeed, you 

had a fine education at Marquette University, where I received my 

undergraduate degree. You didn’t know that, huh? 

Chairman MANZULLO. No, I did not know that. 

Ms. MOORE. Well, I have been waiting to tell you that. 

[Laughter.] 

Ms. MOORE. And I want to thank our Ranking Member— 

Chairman MANZULLO. At least the SBIC program can take credit 

for bringing people together here. 

Ms. MOORE. I want to thank you all for just your diligence in this 

area. 

I guess my question is something that I want to address to both 

of our witnesses. And I am very pleased that you have come today. 

16

I have heard, I guess I want to start with Mr. Guzman. I think 

that you have spent a lot of focus of your testimony on the costs, 

the initial outlays of the federal government. And you know, if 

there is this great reduction in risk, there is also a reduction in the 

productivity. 

And I was reminded of a sort of statement that I had learned 

early on in life, that the absence of stress is death. 

And what I am concerned with is that literally, some astronomical figure, like 90 percent of all of our businesses are small businesses. And if we are destroying the SBIC program, there has been 

absolutely no support from the President on the new markets venture capital program, which seeded these early-generation businesses. 

And all of the private venture capitalists that we see outside of 

the SBIC have really, really do not contribute to a diversified economic landscape in the United States. Literally, over half of the 

venture capital funds are focused on like California and Massachusetts. They focus on high-tech programs, and a few little niche 

areas, as opposed to manufacturing. 

I live in a state and in a city, in Milwaukee, in Wisconsin. We 

are like 48th out of 49 in the nation for being able to attract venture capital. And it would just kill us to have this debenture program, which favors, as our Ranking Member pointed out, favors 

businesses that are already launched. 

And so I guess ultimately my question is, are we headed for an 

economic, are we being penny-wise and pound-foolish? We save a 

couple of dollars, we do not make the appropriations. We call for 

a zero risk to the federal government. We divest totally in equity 

investments. I mean, you know, no support for the new venture 

capital program, which functions in these low-income geographic 

areas. This debenture program that does not help newly-generated 

businesses. And then the private capital that we have concentrated 

in two states, in a very small field. 

Where are we going globally? 

Mr. GUZMAN-FOURNIER. On the question of new markets, I want 

to make sure that you know that we are keeping track of that program internally. We have it as part of our measures that we have 

in the Investment Division to make sure that we know, at the end 

of the day—I think it has probably another year or so until we see 

how those companies have really done. 

Their investment cycle right now is at year three or four. So by 

year five, we are expecting to see whether those six new market 

SBICs, where they stand generally. So I wanted to clarify that. We 

are keeping track— 

Ms. MOORE. I just want to stop you for a second, because that 

five-year benchmark, it has the same flaws and foibles I think that 

Mr. Mercer and our Ranking Member were trying to point out. 

I mean, the whole point in venture capital is that you are supposed to be patient. 

Mr. GUZMAN-FOURNIER. Right. 

Ms. MOORE. You are not supposed to eat up your success by having to repay. So if five years is your benchmark, I am getting 

scared already. But go on. 

17

Mr. GUZMAN-FOURNIER. Yes. I mean, it is early enough for us to 

start looking at results. I am not saying that at the fifth year we 

are going to make a final determination here, but we are going to 

start looking at actual results. 

On your other question, I can tell you that we have a debentures 

program, and that program is running. We are licensing funds in 

that area. That program is currently meeting the needs of small 

businesses, and it is running at a zero cost to the government, as 

we speak. 

And what happened with the participating program was that we 

saw the cash position deteriorating in the billions, which really 

causes concern to anybody. And you have to really look at why 

what the structure of that program was that caused this to happen. 

And this proposal relooks at that program, and sees how can we 

make this structure work. But it is a complex proposal. And that 

is why I have come here to say that we are looking at it, and we 

have submitted questions, and we are communicating with the 

committee in terms of questions and answers right now to figure 

out how to move forward. 

Ms. MOORE. Well, Mr. Guzman, you know, I am a person who 

just does not buy lottery tickets. And so I am never going to win 

the lottery. 

And I guess, Mr. Mercer, I would ask you to pick up from, you 

know, on my questions. I mean, what is the break-even point for 

the United States’ economy? If we run scared with some losses, and 

a billion dollars is a lot of money. If we run scared and we don’t 

start making investments in those dynamic companies—and I am 

thinking of Staples, I am thinking of, you know, Starbucks, I am 

thinking of— 

Chairman MANZULLO. Build-A-Bear. 

Ms. MOORE. Build-A-Bear, you know. I am thinking of these companies that just really, you know, if we wait until they start succeeding before we are willing to invest in them, or if we start calling in their equity after five years, I am wondering where we are 

headed in terms of our ability to be competitive globally. Considering that 90 percent, some astronomical number of small businesses keep our boat afloat. 

Mr. MERCER. I agree with what you said, and I would like to go 

back. In addressing your question, I would like to do a couple 

things. 

One, HR 3429 tries to strike a balance by deferring, first of all, 

the legislation was restrained by the Credit Reform Act in that, for 

subsidy purposes, for creating a subsidy program, it had to be a 

debt security. 

A debt security could exist with interest deferred for the full 10 

years, still chargeable against capital, still a debt instrument in the 

eyes of the law, the tax law, the GAAP accounting rules, and I 

think would pass Credit Reform Act. 

The longer interest is deferred, the more likely it is that those 

who are involved in the program can make early-stage investments. No question about it. If interest is not deferred at all, like 

in the current straight debenture program, that is not a program 

for early-stage investments. 

18

The longer you defer the interest in a debt instrument, the more 

you encourage people to be able to make early-stage investments. 

In terms of, to go back to Ms. Velazquez’s question about is startup capital the biggest gap in the country. In a certain sense, the 

overall answer to that is yes. But as experts testified in April, 

there are other gaps that exist, such as in manufacturing, venture 

capital for small manufacturing companies. That capital for those 

companies is generally for later-stage companies. 

So there is different kinds of gaps that are at work here. And HR 

3429 would be attractive to venture capitalists investing in small 

manufacturing companies, because those companies do have cash 

flows, and by the fifth year they should be able to do it. 

So it is a balance. And there is no perfect answer. I am a sailor, 

and there is no perfect boat, you know? You just keep tinkering 

with the design. There is no perfect tennis racquet. Mrs. Velazquez 

is an adamant tennis player, and I know she knows there is no perfect tennis racquet. 

Ms. MOORE. Mr. Chairman, will you indulge me just to ask the 

panel another question? Ms. Velazquez really embarked upon a discussion that I would like you guys to respond to. 

You know, minority businesses are very, very volatile. In my 

home state, in my home town, I think Hispanic companies in Wisconsin are like—African-American and Hispanic companies in my 

town— 

Chairman MANZULLO. Mrs. Moore, would you want a minute to 

regroup your thoughts for that question? Would that be okay? And 

then I have just got a very short question here, and then we can 

go to you, and then back to Mrs. Velazquez again. 

I am going to draft a letter that Mrs. Velazquez and I will sign, 

that I am going to direct the SBA to come up with a legal opinion 

as to whether or not this is within the parameters of the Credit Reform Act. And I am going to give you a drop-dead deadline to answer that question. 

And if it is not answered, I am going to have a hearing here. And 

you can bring your lawyer here, and OMB can bring their lawyer 

here, and we will have somebody else here. I want to get this thing 

answered. 

Because I just have the gut feeling that the SBA wants to deepsix this thing, and not come to a conclusion, based upon the fact 

that we had given three weeks to the SBA to respond. And on Friday, this past Friday, came back with 35 questions. And those were 

answered over the weekend by Mr. Mercer. 

Ms. VELAZQUEZ. Mr. Chairman? 

Chairman MANZULLO. Yes, go ahead. 

Ms. VELAZQUEZ. I would like to mention in the letter to include 

a response from the Administration whether or not they support or 

oppose this legislation, the proposed— 

Chairman MANZULLO. We can do that. That would be fine. 

And the other question is, how many attorneys at the SBA are 

working on this issue? 

Mr. GUZMAN-FOURNIER. How many attorneys? 

Chairman MANZULLO. Yes. 

Mr. GUZMAN-FOURNIER. Not many. 

Chairman MANZULLO. Well, how many? 

19

Mr. GUZMAN-FOURNIER. Do you need a number? 

Chairman MANZULLO. Yes, I need to know. I mean, I want an answer to this. 

Mr. GUZMAN-FOURNIER. I tell you, my staff is leading this, the 

Investment Division. It is not being led by attorneys. 

The proposal has, obviously, legal ramifications— 

Chairman MANZULLO. That is correct. 

Mr. GUZMAN-FOURNIER. —and they are looking at those, because 

we are not legal experts. 

Chairman MANZULLO. Right. 

Mr. GUZMAN-FOURNIER. But the way we work is, the Investment 

Division leads, in terms of the policy analysis. And we have lawyers that assist us on the legal side of it. Which is like I think any 

other Committee works. 

Chairman MANZULLO. Sure. Okay, Mrs. Velazquez. 

Ms. VELAZQUEZ. I gather that not too many, Mr. Guzman, since 

the budget has been cut by almost 50 percent. You can’t have that 

many. Yes, sure. 

Chairman MANZULLO. Ms. Moore, do you want to finish up? Go 

ahead. 

Ms. MOORE. Thank you so much, Mr. Chairman. I have regrouped. 

I represent Milwaukee, Wisconsin; it is the largest city in my district. And the city of Milwaukee, among the 50 largest metropolitan 

areas in terms of black-owned businesses, ranks 48th for AfricanAmerican-owned businesses. And, sorry about this, 49th for Hispanic-owned firms. 

So by definition, if there were any venture capitalists that were 

going to help Hispanic- and African-American-owned businesses, 

they would, by definition, be start-ups. 

And so to the extent—I mentioned the new market venture capital program, which, you know, the Administration rescinded the 

funding for any new projects for that program. And then this proposed debenture program is more geared toward medium-size already-generated businesses. 

What commitment does the federal government have to helping 

minority-owned businesses, when you are scaling back and destroying those programs that have the potential to enable, to build the 

capacity for those businesses? 

And we have got 59-percent unemployment rate among AfricanAmerican men and men of color. So to the extent that we don’t 

have businesses generating, those minority, you know, there is a 

correlation between the unemployment. This is a real crisis. This 

is why I am here. 

They elected me to bring some resources to town. And what can 

I tell them that the Administration is doing specifically to help minority unemployment, ultimately? 

Thank you, Mr. Chairman. 

Mr. GUZMAN-FOURNIER. Well, I would go back to the programs 

that SBA has and its ability to— 

Ms. MOORE. You rescinded the funding for the New Markets program. 

Mr. GUZMAN-FOURNIER. Right. No— 

20

Ms. MOORE. So there is no new round of funding for any Latino 

business in Milwaukee, under that program. 

Mr. GUZMAN-FOURNIER. No, but we do have folks that are serving Latino communities within the regular, traditional SBIC under 

both the Participating and the Debentures program. 

But going back to your question, we do have other access to capital at the agency. And we are proud of our record. And I know 

some people might disagree, but we are very proud of our record 

in terms of the loan programs in this agency since this Administration took over. 

We have increased the number of loans going into these segments of the population that you mentioned. And there has been 

a concerted effort within the agency to look at this area. 

So we are proud. I can tell you personally that I am committed, 

also, within the SBIC structure, to look at this area. And I have 

been— 

Ms. VELAZQUEZ. Would the gentlelady— 

Mr. GUZMAN-FOURNIER. —committed for the last two and a half 

years. 

Ms. VELAZQUEZ. —yield to me? What programs? Prime, Business 

Link. Every single program that has been crafted and designed to 

help low-income minority businesses has been zeroed out, or their 

funding cut. So what programs? 

Chairman MANZULLO. Ms. Moore, could I ask you a question? 

Ms. MOORE. Yes, sir. 

Chairman MANZULLO. Could you give me that statistic again, 

and try to explain that? 

Ms. MOORE. The top 50 cities— 

Chairman MANZULLO. You mean in terms of population. 

Ms. MOORE. The largest metropolitan areas in terms of blackand Hispanic-owned firms, according to the Center for Economic 

Development at the University of Wisconsin, Milwaukee, Milwaukee ranks 48th among the 50 largest metropolitan areas for 

black-owned businesses—I have got a friend who went to Marquette who is an engineer thinking about just moving out of Milwaukee—and 49th for Hispanic-owned businesses. 

Chairman MANZULLO. Could you quantify? 

Ms. MOORE. Provide the study? Yes, sir. 

Chairman MANZULLO. Is there a reason for that within Milwaukee? Milwaukee is a great city. 

Ms. MOORE. Well, for one thing, you know, it had a manufacturing base. And to the extent that venture capitalists are moving 

away from manufacturing—we still have many small manufacturers that are trying to generate business—you know, that could be 

one of the explanations. 

But just those data that the staff for this Committee provided is 

a key. That Massachusetts, California—I mean, the midwest is 

being ignored. 

Chairman MANZULLO. We had a situation in Rockford, Illinois, with Ingersoll Production Line—this was about 130 years ago. This is the company that 

actually invented the assembly line. I mean, this is what Henry 

Ford had used as a prototype. It was in the process of going under. 

And we had lost Ingersoll Cutting Tools Division to bankruptcy—

21

then an Israeli firm came in. Ingersoll Machine Tools eventually 

was sold to an Italian firm. 

And here was Ingersoll Production Line, this wonderful company, 

and the man who had run it came out of retirement. We went to 

10 joint venture capital firms and banks. No one was interested in 

buying it. 

And so he went to Dalian which was a wholly-owned, stateowned, Chinese company, that came to Rockford, Illinois, bought 

this company, and has a very hands-off attitude. I mean, it allows 

the people in Rockford to run this. And they are making machine 

tools for production lines, and exporting those to China. 

I mean, this is extraordinary. And the problems that we are seeing—and you can’t tell investors where to put their money, because 

there is always a risk, including the taxpayers. Everything seems 

to go into high tech. And that is why you have the Massachusetts 

and the California experience. But our basic industries are just 

really hurting. Could that be one of the reasons? 

Ms. MOORE. Yes, I couldn’t agree with you more. I mean, as a 

State Senator, I focused on venture capital. And I was a little bit 

protectionist. I am trying to make sure that those investors would 

receive a 50-percent tax credit for investments in firms in Wisconsin. 

Because the closest new market firm to Milwaukee, Wisconsin is 

in Ohio. That is like an eight-hour drive. 

So when you say that they are helping, we have a strong manufacturing base. Harley Davidson—I know you have heard of Harley 

Davidson, a very successful company. But when they were in trouble, they were out there with a tin cup trying to get banks to help 

bail them out. Manufacturing. 

We have J. I. Case, the farm equipment producer, headquartered 

right in Racine, Wisconsin, where I was born, 27 miles from Milwaukee. And eventually a foreign company purchased J. I. Case. 

But we are having problems with the transitioning in our manufacturing culture. Because we still have many small tooling places, 

and we are being vastly ignored. 

Now, to the extent that the SBA had been the primary source of 

venture capital for manufacturing-type companies, you are the first 

and last hope. So that if there is an unwillingness on the part of 

SBA to continue accepting that risk, we are in a lurch in Milwaukee, Wisconsin. 

And I would love it, Mr. Chairman and Madame Ranking Member, if we can be involved in the letter, and some of the appendices, 

to demonstrate the crisis that we are in. 

Mr. GUZMAN-FOURNIER. I wanted to add that for manufacturing 

in particular, the structure of the debenture program is suitable. 

So— 

Ms. MOORE. For start-ups. 

Mr. GUZMAN-FOURNIER. I would be interested in—manufacturing 

start-ups, or just manufacturing, period? 

Ms. MOORE. Well, start-ups. We have some, I am thinking right 

now of some small companies that are making tools and small 

parts. And they are essentially start-ups, in terms of their generation. 

22

And I am concerned—and they are also operating in these lowincome geographic areas. Milwaukee, the city of Milwaukee qualifies. And the reason that I prioritized getting here today is because 

I wanted to hear how flexible this new proposal is. 

And to the extent that you are so risk-averse—and if I am wrong, 

Mr. Mercer, please correct me—I think that you apologized almost 

for the program, saying that we are constrained by some prior law 

that has been passed. But it seems that we need to revisit that, as 

well. Because I don’t know how flexible this new program will be 

in terms of helping a place like Wisconsin. 

Mr. MERCER. Well, I mean, it can help. It can’t solve all problems, there is no question about it. 

But if you look at the Participating Security program which it 

would replace, about 35 percent of investments made in that program over the past several years have been in manufacturing companies. 

Now, those are not all in start-up manufacturing companies. Because, as you know, manufacturing companies, even after they 

have been in existence for a while, often need an infusion of additional equity to build a balance sheet that will allow them to put 

on senior debt for expansion, and things like that. 

So the structure in 3429 can encourage, and would encourage, 

that kind of investing. 

But Ms. Velazquez is correct when she says the structure in 

3429, which has only a five-year deferral rate for interest, would 

make it difficult for funds to focus on start-up businesses. There is 

no question about that. That is the balancing. 

And that is why I say if the Committee wants to focus more on 

start-ups and still meet Credit Reform Act, then it has to consider 

deferring interest a little bit longer, because it is a cash-flow game. 

Ms. MOORE. Right. 

Mr. MERCER. That is what it is. And that is a balancing act that 

will impact subsidy rates and other things. And I am not here to 

tell you that I know what the right answer is. It really depends on 

how the Committee wants to focus. 

Ms. MOORE. Thank you for your indulgence, Mr. Chairman. And 

I really, really appreciate Mr. Mercer being here. 

I think often of a company in Milwaukee that was a meat manufacturer, very small, black-owned business, that got a lucrative contract with McDonald’s to produce the sausage for their sausage 

breakfast sandwich. And they made tremendous investments, capital investments in order to be able to conduct this contract. Only 

to have their notes called—you know, their loans and equity investments being called too early. So that they found they didn’t have 

the cash flow. Even though they had a lucrative contract. And it 

really destroyed, you know, the lucrative contract almost destroyed 

their business, because they couldn’t keep pace, because they had 

to be repaying these debentures. 

So that is what I am concerned about. We have got to be patient. 

Because, you know, I want to win this globalization thing. You 

know, I want my kids and grandkids to be able to work here. I 

don’t want them to have to move to China in order to have a job. 

Thank you, Mr. Chairman. 

23

Ms. VELAZQUEZ. I would like for you to give us some background 

in terms of where we find ourselves, the Committee, the SBIC companies and the program, and the proposal that we have before us. 

Can you provide the Committee with what NASBIC took, once 

they recognized the challenges that the participating securities 

faced? In particular, can you tell us about the Administration’s role 

in the process? 

Mr. MERCER. Well— 

Ms. VELAZQUEZ. I just want to know, did you reach out to them? 

Mr. MERCER. Yes. 

Ms. VELAZQUEZ. Have any conversations? And what the Administration told you, in terms of coming up with solutions to deal with 

the challenges that you were facing? 

Mr. MERCER. Well, we have asked repeatedly to be able to sit 

down to design a successor program to the Participating Security 

program, in a collaborative environment. And the Administration 

has said that it is not necessarily absolutely opposed to a successor 

program, but that it would respond to proposals; it would not participate in the process of developing the proposals. 

That is why I said I was heartened by reading Mr. Guzman’s testimony today, where it seemed to indicate for the first time that 

they might be willing to sit down with members of the Committee 

and their staffs, and hopefully to start to get into the intricacies 

of the structure. Because it is a technical area, and it is very difficult for one side to come up with a proposal that meets 

everybody’s needs. 

Ms. VELAZQUEZ. So Mr. Guzman, is his assessment correct? 

Mr. GUZMAN-FOURNIER. Yes. We have said that we are willing to 

work with the Committee. 

Ms. VELAZQUEZ. So you are going to sit down with NASBIC and 

discuss the proposal, and come up with solutions? 

Mr. GUZMAN-FOURNIER. In a way we are already doing it. Because, you know, the Committee was offered our response to a proposal. And our response was that, as Lee just said, this is a complex legislation which requires complex analysis, which— 

Ms. VELAZQUEZ. I heard that before. 

Mr. GUZMAN-FOURNIER. —in our case is, it came up to 35. We 

weren’t meaning to have 35 questions, but that is the extent of 

what we thought was important to— 

Ms. VELAZQUEZ. That doesn’t tell me much. 

Mr. GUZMAN-FOURNIER. It is a technical, as Lee said, a technical 

proposal. So we definitely want to look into each aspect of it. But 

that— 

Ms. VELAZQUEZ. Okay, so the Administration is willing to sit 

down, discuss this complex proposal, and reach whatever compromise or solution, so that we can move this thing forward. 

Mr. GUZMAN-FOURNIER. At this point, we are already doing it. 

We are in discussions with the Committee. 

Ms. VELAZQUEZ. Mr. Lee, what is your estimate of how often the 

SBA will receive a profit participation under your proposal? 

Mr. MERCER. If, I am trying to now recall industry statistics over 

the past 20 years. Industry tracks funds by quartiles. So if the licensing is good, and I think SBA has improved its licensing criteria 

over the years, so they are picking very qualified investment proVerDate 0ct 09 2002 12:53 Dec 01, 2005 Jkt 000000 PO 00000 Frm 00027 Fmt 6633 Sfmt 6633 G:\HEARINGS\23182.TXT MIKE
24

fessionals, these funds should perform to industry averages. Which 

would mean the top three quartiles of funds are profitable. The bottom quartile of funds are not profitable. 

So in three quarter of the funds, there should be at least some 

profit participation. 

Now, what the Committee should understand is the top quartile 

of funds is the one that drives the biggest returns in venture capital. So the reason the proposal suggests a higher profit participation in the most successful funds is to enable SBA to take advantage of that top quartile of funds. And that, we hope, would do it. 

Ms. VELAZQUEZ. Mr. Guzman, what is your assessment of that? 

Mr. GUZMAN-FOURNIER. Well, this is an area where we have 

some concerns, in the sense that we are looking at it as a potential 

cross-subsidization of non-performing SBICs by high-performing 

SBICs. 

And it is something that, again, I think in a cash flow scenario, 

when you see the scenario analysis, you might have a better sense 

of the numbers. But it is something that worries use, that Lee just 

mentioned. 

Ms. VELAZQUEZ. Mr. Lee, can you further explain the conditions 

that private investors will be able to receive a distribution before 

the SBA is paid back? 

Mr. MERCER. The first thing that would happen is that interest 

would be paid back before anybody gets anything. And after that, 

amounts distributed would be distributed pro rata. In other words, 

if SBA had 50 percent, had provided, the SBA had guaranteed 

money, because it is not a direct-funded program. But if SBA guaranteed money was 50 percent, they would get 50 percent of the distribution. If it was greater than 50 percent, they would get greater 

than 50 percent of the distribution. 

So the repayment of debt, if you will, on the SBA-guaranteed 

capital, and the repayment of private investors on their equity accounts, would occur on a pro rata basis. And that, as you correctly 

stated in your opening statement, there has to be, in the development of any program, there has to be a balance that will keep the 

private investors attracted, as well as balancing the risk of the taxpayers. And that is one of those balancing— 

Ms. VELAZQUEZ. But let me ask you, could private investors receive distributions ahead of SBA? 

Mr. MERCER. No. 

Ms. VELAZQUEZ. And my last question, Mr. Chairman. Given the 

role that the pension funds play and university endowments plays 

on financing the program, have these major investors endorsed this 

proposal? 

Mr. MERCER. They have not taken a position on the proposal, no. 

Ms. VELAZQUEZ. Well, I have some other questions that are important, and I will submit those in writing. 

Mr. MERCER. One interesting note, I think, and it has been mentioned before, that you bring up pension plans. The biggest pension 

plan, of course, is CalPERS, a huge investment in venture capital 

funds. 

And if you recalculate the Participating Security returns for the 

vintage years 1994 through 2000, and calculate what SBA would 

have gotten if it had been a regular limited partner, like CalPERS 

25

was in the funds it invested in, the SBICs performed exactly the 

same, if not a little better, than the non-SBIC venture funds that 

CalPERS invested in. 

So that is why I think I am confident in saying that these funds 

should perform to industry averages. 

Ms. VELAZQUEZ. Mr. Chairman, I have another question for you. 

Chairman MANZULLO. I have got another meeting at 1. 

Ms. VELAZQUEZ. I would just like to know if we could have another hearing where we could have OMB and all these investors, 

so that they could comment. 

Chairman MANZULLO. Well, we may end up with a hearing with 

all the lawyers here, if we don’t get some answers on it. But we 

will take that under consideration. We obviously both have an interest in this. 

You have both been very generous with your time. And this hearing is adjourned. 

Mr. MERCER. Thank you, Mr. Chairman. Thank you, Ms. Velazquez. 

Mr. GUZMAN-FOURNIER. Thank you. 

[Whereupon, at 11:40 a.m., the Committee was adjourned.]

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